Here are the two headwinds that LULU shareholders face in the coming quarter.
First of all, competition in the yoga wear industry is about to explode. Gap (NYSE:GPS), Nordstrom and Nike (NYSE:NKE) have all entered the yoga athletic gear. They plan to compete directly with LULU, and some competitors like Nordstrom (NYSE:JWN) sell similar gear for 30% below LULU's prices.
Signs of competitive pressures appeared last quarter where the retailer predicted low- to mid-teen same-store sales gains in the upcoming quarter. Analysts were expecting 20% same-store sales gains. The slowing growth is most likely a combination of increased competition and the slowing economy.
I expect the operating margins at LULU will struggle in coming quarters. The competition is trying to steal the highly trained staff from LULU which means that LULU has had to increase compensation.
“What we are very conscious of is, with a lot of knockoffs coming into the marketplace, if you hire a few Lululemon people you have got really a trained program,” Christine Day, chief executive officer of Lululemon, said in explaining the higher compensation. “We want to make sure that our educators [store staff] know that they are valued for the work that they do … Part of our key strategy is making sure that our store managers and our educators are paid very well comparatively in the marketplace. Because that is what gives us that community constancy which is critical to the brand.”
During a recent conference presentation, CFO John Currie surprised the market by mentioning that 28% operating margins the company reported for its second quarter is "deliberately not sustainable." Curie said that the company plans to invest for further growth by adding new stores. He noted that a few years ago, the company's target was 20%. The long-term target is now 25%, he said.
The most likely reason for the margin compression is competition and staff compensation costs. The long-term operating margins for LULU will most likely be 15%, far below current analyst estimates. After all, how many specialty retailers have 25% margins? By way of comparison, Nike has 13% margins and Under Armor has 10% margins.
For these two reasons the coming quarters at LULU could surprise shareholders to the downside.